BOE pressured to raise interest rates to cool housing prices across the UK

British housing prices rose nearly 12% over the past year, with average prices in London up a shocking 25.8% over the same time period. Amid speculation of a growing housing bubble, the Bank of England has warned that it may soon be forced to raise the historically low interest rates in an attempt to slow runaway housing prices.

Buyers in London are already facing record housing prices, with average properties costing a whopping £400,000. This boom has not gone unnoticed by developers who are rushing to capitalise on the gains through additional construction. The entire situation is fueling fears that a housing bubble has developed, stoking concerns that a repeat of the 2008 housing crisis could be in the works.

Speculators are responsible for some of the recent run up in prices. Many foreign investors are pouring money into London properties to take advantage of the rapid increase in prices. A 25.8% increase in property values trumps most equities portfolios during the current year. There are two primary concerns about the rapid increases.

New Housing Bubble?

Are the current price increases sustainable? The recent increases largely mirror the gains experienced by property owners immediately preceding the 2008 financial crisis in the UK.

Some economists are warning of a potentially disastrous bubble in housing prices and what it could mean for the greater economy. If housing costs rise well above their inherent values, property owners could be in jeopardy of an economic shock that could send prices plummeting. Anyone who recently purchased a home at an inflated price could be looking at a huge equity loss, making liquidation of the investment nearly impossible.

Workers Priced Out of Home Ownership

Since housing prices are rising at such a rapid rate, those earning modest salaries will no longer be able to afford to buy a home in most neighbourhoods of London and other high-priced property markets across the country. Salaries have remained flat while home prices are skyrocketing.

Lending standards are also fairly strict. Underwriting criteria were tightened in April 2014, leading many would-be buyers unable to prove they would be able to afford to repay the loans. If you are seeking to borrow less than 4 and a half times your annual salary, you probably won’t notice much of a change. Buyers in London are the most likely to see a shift in underwriting guidelines that could reduce their overall borrowing limits.

Higher Interest Rates

Interest rates have been kept at artificially low levels since the 2008 crisis. For now, BoE is keeping rates at historically low rates of 0.5% for at least another month.  This may be about to change as early as late 2014.

The Bank of England may have little recourse but to start raising rates as it attempts to reign in record housing prices. Among other things, this will increase the monthly payment on a home mortgage. The challenge is to slow down the pricing increases without slowing down the greater economy. Higher interest rates are likely to reduce construction activity, which could reduce economic output.

Something will eventually have to be done though, since unaffordable housing prices will also cause economic instability. It is this type of economic shock that BoE will seek to avoid. By gradually raising interest rates, the goal is to slow down the growth of home prices without triggering wider economic repercussions.

Residents who are seeking to buy a home may find it more difficult to qualify for the higher home prices. Higher interest rates will also reduce what they can borrow. The higher housing prices are already spilling over into rental markets, with average rents also increasing at a pace much faster than salaries are increasing.

Those who are unable to afford the higher home prices and rental rates are already turning to housing assistance programmes as they seek aid in making their rent payments. With affordability of housing getting worse, BoE will have to act soon.